The price of jet fuel has taken off over the past year and passengers may get left behind. Delta Air Lines, Inc. (DAL) lowered its profit forecast on Wednesday after the recent surge in fuel prices, about 50% higher over the past several quarters. Delta Air Lines provides scheduled air transportation for passengers and cargo throughout the United States and across the world. For the second quarter the major American airline has decreased its expected profit from a range of $1.80 to 2.00, to a lower range of $1.65 to $1.75, according to CNBC. There is strong demand for air travel, especially as we get closer to the summer busy season. But the major challenge for not just Delta, but all airlines is the higher input cost of doing business. One of Delta’s competitors, American Airlines has predicted it will spend $2 billion in additional costs this year.
Major airlines are raising fares reversing a four year trend. Fuel has fallen as a proportion of total cost to airlines in recent years but still count for about 20% of all operating expenses. Airlines are still expected to be profitable this year in part because new fees imposed in recent years have given the carriers an additional degree of financial insulation from price shocks.
According to investment analyst Christopher Higgins at Tufts University Investment Office, DAL is currently under priced. He says, “Delta remains one of the best-managed airlines, with the highest operating margins among U.S network carriers, a clean balance sheet, and a commitment to returning 70% of its free cash flow to investors. Thanks to industry consolidation, Delta’s operating margins should remain positive across the full cycle. This signals a clear break with much of the industry’s history, which featured boom-bust cycles.” Higgins is not alone in his bullish outlook for Delta. The average 12 month price target for DAL, according to 16 analysts who cover the stock, is $72.30, which would be a 35% increase from today’s price of $53.46 per share.
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Delta’s earnings have been declining for the past few years. But investors are hoping the company can pass on the cost to passengers in the long run. Despite a notoriously bad long term history, now may be a good time to start looking at investing in airlines. Southwest, Delta, and Air Canada are a few publicly traded companies that are well managed and stand to gain the most from rising air travel demand.
DAL is benefiting from strong industry fundamentals, including moderate capacity growth, growing ancillary revenue, and rising demand for air travel as more people in less developed countries grow into a more middle class lifestyle. Delta is also upgrading its fleet with newer, more fuel-efficient planes. In addition, Delta is adding to its route network and expanding globally through partnerships with international carriers. But it is not clear whether or not these benefits will completely offset the impact of higher fuel prices. Airline stocks have a history of being volatile in the past and is suitable only for investors who can stomach the risk. As Bryden Teich, portfolio manager at Avenue Investment Management would say, “You could come up with a million and one issues of why you would never want to own an airline, but at the same time you could make an argument that you are in the sweet spot of a cycle for the airlines.”
This author does not have any shares in DAL and does not plan to own any within 72 hours of this post.